“Goodly Lord, what a wit-snapper are you!” (Merchant of Venice, III.v.45)

Changing market rules in mid-game…UPDATE: The larger question

One of my favorite free-market economists, CNBC’s Larry Kudlow, writes that it was a “terrible idea” for SEC Chairman Chris Cox to ban short selling in an effort to keep the stock market from sinking even lower.

Short selling, or trading stocks in such a manner that you are effectively betting that the share price will decline, provides a balance to traders who (all too often) put too much faith in corporations’ own friendly reporters and media releases. In Kudlow’s words, short sellers “keep the market honest,” preventing stock prices from inflating past their realistic worth.

In a broader sense, even a relative economic dilettante like myself knows that banning short selling, even for a little while, is an improper government intrusion onto the market and a general betrayal of free-market principles. Once, back when Chairman Cox was Congressman Cox, he was a staunch defender of those principles, a solid Friedmanite. It’s becoming apparent why John McCain was thundering for Cox’s ouster yesterday.

Click the link above and read Kudlow’s post, including his assessment of what Cox should have done. An UPDATE addressing a bigger question not addressed above follows below the break.

UPDATE: A couple of readers (yes, miraculously, I do have them) have pointed out the elephant in the room: what do I think of the series of proposed corporate bailouts of the past week? My answer is the reason I haven’t said much about them yet: I’m not quite sure.

The small-government free-marketeer in me is very uncomfortable with keeping failing companies afloat with public money. Failing companies, ideally, should be allowed to fail and make room for their prospering competitors; that’s the essence of free enterprise. Companies described as so large that they’d bring much of the economy down with them if they failed — in the vernacular of the day, “too big to fail” — are, by definition, simply too big, period. We’ve broken up companies before when they got too big, and that is a last-ditch but legitimate function of government. Leaving an economy dependent on a handful of enormous companies is not how a free market works; it’s how a free market collapses.

On the other hand, now that these “too big to fail” companies are already tanking, breaking them up is not really an option anymore (unless you want a huge pile of smaller, failing companies). The “tough love” approach described above is principled and decisive in theory, but at this late date it doesn’t sound like a luxury we can afford. Propping these companies up until they get back on their feet is really the only option left, or we’re looking at another Great Depression — another giant market crash/credit crunch/bank failure which was not followed up by a series of bailouts.